IFRS Goodwill Impairment Test - Audit Approach, Earnings Management, and Capital Market Perception

This dissertation addresses the goodwill impairment test under IFRS, which prescribes that goodwill is not amortized and instead tested for impairment at least once a year. The objective of introducing this impairment-only approach in 2004 was to provide more useful information to financial statement users. The dissertation is thereforemotivated by the ongoing debate on the decision usefulness and reliability of goodwill impairment tests, as the IASB’s recent post-implementation review on business combinations shows, and the high practical relevance of this topic for firms, auditors, enforcement institutions, and regulators. Against this background, the dissertation (1) sets forth and critically discusses the accounting requirements for goodwill, (2) develops an audit approach for goodwill impairment tests, (3) empirically assesses whether goodwill impairment tests are used as a device for earnings management, and (4) performs two empirical studies to analyze how goodwill impairments are perceived by capital market participants. Based on the requirements of international and German auditing standards and the author’s practical audit experience, a risk-based audit approach is developed that outlines the different audit steps necessary to verify the reasonableness of goodwill impairment tests including practical application guidance for auditors. Using a sample of German listed firms for the periods 2006 to 2013, the main findings of the three empirical studies are that (1) the likelihood to recognize goodwill impairments and the magnitude of impairment losses are influenced by earnings management incentives, (2) investors perceive goodwill impairments as value relevant, but not timely recognized, and (3) the announcement of goodwill impairments leads to a negative capital market reaction, but the reaction is considerably smaller than the goodwill amount written off. Moreover, the perceived timeliness of goodwill impairments is shown to be influenced by auditor characteristics, which serve as a proxy for perceived audit quality. Overall, the empirical results therefore indicate that the concept of impairment testing might generally have merits in reflecting the economic value and consumption of goodwill, but that current accounting requirements might not be sufficient to ensure a rigorous impairment test providing adequate decision useful information. Hence, improvements of the current approach or the implementation of a different approach, e.g. based on certain amortization requirements with indication-based impairment testing, should be discussed.